Accounting Basics:

Accounting is different from finance and this POME Chapter explains the differen
ces. The definition and demonstration of basic accounting tools provide you with
the understanding you need to participate in discussions of financial matters w
ith others.
You will be introduced to some basic accounting principles and other accounting
basics in an easy-to-understand format. Some of the vocabulary words may be new
to you, but once you become familiar with some of the terms of basic accounting,
you will feel comfortable navigating through any of the topics in Accounting of
daily operations.
Some of the basic accounting terms that you will learn in accounting basics are
revenues, expenses, assets, liabilities, and the balance sheet for your Projects
.
You will become familiar with accounting debits and credits as we show you how t
o record transactions for your Projects. You will also see why two basic account
ing principles, the revenue recognition principle and the matching principle, as
sure that a Project's income statement reports a Project's profitability.
The Accounting System
The accounting system is the bookkeeping portion of financial management. It def
ines what goes in what category on the Income Statement or the Balance Sheet. In
addition, an accounting system accomplishes the following functions:
Identifies and records all transactions. The accounting system needs to handle a
nd control all transactional documentation quickly and correctly: incoming and o
utgoing invoices, incoming and outgoing payments, orders, payroll items, and all
other business activities.
Describes accounting events on a timely basis. As we noted earlier, immediately
recording and recognizing financial effects allows organizations to respond effe
ctively and quickly to challenges or opportunities.
Measures the value of transactions properly. The accounting system must assign a
ppropriate values to transactions, particularly those for which the value is not
obvious, such as the inventory value and, therefore, cost of product produced o
r held for sale. The accurate valuation helps assure accuracy, which is necessar
y if an organization is to manage effectively.
Ensures recording in the proper time period(s). Financial reporting is most valu
able when it provides an accurate assessment of the status of the business. By r
ecording transactions in the appropriate time period, plans and forecasts as wel
l as operations themselves can be properly evaluated.
Presents and discloses accounting events properly. Proper treatment permits outs
iders to evaluate the success of the business, whether they are the board of dir
ectors, investors, lenders, vendors, customers, or anyone else. Timely reporting
and disclosure increases the value of everything about the business.
Who Uses Accounting Information?
Accounting information is valuable to everyone included in a list of company sta
keholders, the various people and organizations that have an interest in the com
pany. Among the stakeholders are
The Board of Directors
Management
Employees
Shareholders
Bankers and other lenders
Customers
Vendors
Competitors
Various federal, state, and local governmental agencies that are interested in t
he company, its industry, taxes, and regulatory compliance
The community as a whole
Anyone else with an interest in the company or its industry These different part
ies use the information produced from the accounting records of the company, but
, obviously, all of them have different interests and perspectives to apply to t
his information. With all these different concerns, the quality of the accountin
g information becomes paramount. The accounting system and the processes followe
d require special attention.
In preparing the financial statements the bookkeepers and accountants must be aw
are of the needs and expectations of the various stakeholders. Consider the exam
ples of the different stakeholders that follow.
The Board of Directors makes policy decisions and develops the future plan for t
he company based on the financial performance and condition of the company as re
flected in the statements. It also takes into account the financial performance
of the company's competition. The importance of accuracy and timeliness is obvio
us.
Similarly, company management makes current and shorter-term decisions using the
same information. Its decisions often respond to the signals found in the state
ments and in the changes in results from period to period. It also responds to t
he financial activities of customers, vendors, and competitors.
In turn, customers, vendors, and competitors analyze financial information for i
ndications of financial strength or weakness, improved or deteriorated performan
ce, and prospects. They make buying, selling, or market response decisions based
on their interpretation of financial results. The analysis of financial stateme
nts provides a real window into business operations.
Employees and prospective employees look at financial information as they make p
ersonal decisions as to employment and personal financial expectations. In today
's competitive employment marketplace it is very common for a prospective employ
ee, before committing to a job offer, to request copies of company financial sta
tements to analyze.
The regulatory agencies of the federal, state, and local governments and the com
munity as a whole are interested in the performance of the company and how it fi
ts into the overall financial picture the viewer is concerned with.
Investors examine financial information of the company before making, retaining,
or disposing of investments in the company. In some cases they rely on the anal
ysis of financial analysts employed by securities brokers and dealers to provide
guidance for their investment decisions.
Bankers and other lenders analyze financial information before deciding to make
loans to the company. Then they examine the periodic financial statements to det
ermine the appropriate actions with regard to the loans they have already made.
If they see a weakening performance, they will be more apt to take protective ac
tion to assure that their loans are secure. If they see strengthening of the fin
ancial performance of the company, they will be more likely to extend further cr
edit and make more money available. As we will see, this improvement in performa
nce that facilitates further borrowing is important to a company, because in man
y cases, business growth creates the need for additional outside funding.
Accounting Is Not Just Cash
Koppala, an opearations accountant welcomed the group and let them know that he
appreciated how hectic it was around the plant these days. "I know a lot of you
have been putting in a lot of extra hours, so I really appreciate the effort you
're making to get together." Koppala asked how many of the group had looked at t
he company financial statements on the intranet. Only a few hands went up.
"We've just started talking about accounting and finance, so those statements wi
ll still be hard to understand. Even so, the sooner you start looking at them, t
he sooner you'll start to see the story they can tell you. After you begin to ge
t familiar with our financial statements, you might go to the Internet and look
up some of the publicly traded companies we compete against to see what their fi
nancial statements look like . . . Chris, I see you've got a question."
"Koppala, I did take a look at our statements and I don't see why it has to be s
o complicated. At home, I pay all my bills, pay my mortgage, and put a little bi
t away. When I balance my checkbook at the end of the month, I can look at what'
s left and see how I did. Why can't we just check the company's cash balance? We
're growing, right? And we have plenty of new orders. Why do we need all that ot
her information?"
"Because we're growing so fast right now, just looking at the cash we have in th
e bank at the end of the month could give a lot of people the wrong idea about t
he company. Our sales are increasing quite rapidly, but we don't get the cash fo
r those sales at the same time we get the orders. We're buying larger quantities
of raw materials every month lately, and we're running extra shiftsâ which means w
e're spending more on labor. We have to lay out that cash before we get the reve
nue for the new sales. The accounting system, by recording transactions in the p
roper period, lets me see how much cash we're going to needâ and explain to the ban
k why we need to increase our credit line. It's not because we're managing badly
; it's because we're growing fast.
"That's why I want every Project Manager in this company to understand what's ha
ppening around here and what kind of impact it will have on the results we share
with the board of directors, our creditors, and the bank. That kind of understa
nding will help you explain to your people why we have to be so careful about co
ntrolling costs."
The Purpose of Accounting
The American Institute of Certified Public Accountants (AICPA) described in 1970
the purpose of accounting: "To provide quantitative information, primarily fina
ncial in nature, about economic entities that is intended to be useful in making
economic decisions." The key word here is "useful." If the information is not u
seful, there is no sense in going through the effort. The following pages look a
t the accounting information and identify its usefulness.
If we handle like transactions or activities in the same way all the time, it is
easy for us to interpret the transactions and understand what is happening to o
ur business. Accounting provides the structure that enables us to process busine
ss transactions in a way that permits consistent treatment, reporting, and inter
pretation. Whereas this portion of financial management was labeled bookkeeping
in the first POME Chapter, it is generally known as the accounting system.
Starting Up a New Business:
George Gautam is a savvy manâ for quite some time he's been noticing the need for a
n efficient Project sub contractor in his customers Projects, and he's been toyi
ng with the idea of starting up such a business himself. George does some backgr
ound research, prepares a business plan, and is pleased to see that he is on the
right trackâ the business plan verifies that his sub contractor service for his cu
stomers Projects would save money for clients while at the same time be profitab
le within a year.
George knows he will sleep better at night if he takes steps to protect his pers
onal assets (his second home and his investments) from any unforeseen lawsuits r
elated to his new business. By forming a corporation, GG Org, Incorporated (or "
Inc.") he limits his liability to only those assets owned by his corporation. In
other words, if someone successfully sues GG Org, Inc., it is possible that the
loss would be limited to the value of GG Org's assets; George's personal assets
might be safe. George continues with the start-up process by obtaining the perm
its and state and federal identification numbers for his new business. So, Georg
e want to start a Business implementation Project.
George is a hard worker and a smart man, but he admits that he is not that comfo
rtable with matters of accounting. In order to have the level of control in his
sub contracting Projects that he wants over his costs and profits for is persona
l Operations, he knows he will have some type of accounting. However; he wants t
o learn more about accounting. George asks his friend Koppala, an Operations acc
ountant, to explain the basics of accounting to him before he appoints an accoun
tant for all his Projects and cumulatively for his Operations and opens for busi
ness. Here is what Koppala tells Georgeâ
Types of accounting and accounting information users
Accounting:
One of the great things about accounting is that it can record all of the financ
ial transactions of GG Org, Inc. George seems puzzled by the term "transaction",
so Koppala gives him five examples of the types of transactions GG Org might ma
ke:
George will no doubt start his business Project by putting some of his own perso
nal money into it. In effect, he is buying shares of GG Org's common stock.
GG Org will need to buy a sturdy, dependable delivery vehicle.
The business will begin earning fees and billing clients for delivering their pa
rcels.
The business will be collecting the fees that were earned.
The business will incur expenses in operating the business, such as a salary for
George, expenses associated with the delivery vehicle, advertising, etc.
There may be thousands of such transactions made in a given year, and this is wh
y George is smart to start using accounting software right from the beginningâ the
software will keep the business's transactions organized and accessible. Account
ing software will generate sales invoices and accounting entries simultaneously,
prepare statements for customers with no additional work, write checks, automat
ically update accounting records, etc.
By getting into the habit of entering all of the day's business transactions int
o his computer, George will be rewarded with fast and easy access to the specifi
c information he will need to make sound business decisions. Koppala tells Georg
e that accounting's "transaction approach" is useful, reliable, and informative.
He has worked with other small Project Managers who think it is enough to simply
"know" their Project made $30,000 during the year (based only on the fact that
it owns $30,000 more than it did on January 1). Those are the people who start o
ff on the wrong foot and end up in Koppala's office looking for financial advice
.
If George enters all of GG Org's transactions into his computer on a routine bas
is, good accounting software will allow George to print out his financial report
s with the click of a button.
Koppala will explain the purposes of the three main reports that George will be
using:
Income Statement
Balance Sheet
Statement of Cash Flows